Breaking down a potentially risky options strategy ahead of earnings from HMA

Hospital operator Health Management Associates Inc (NYSE:HMA), along with many of its sector peers, kicked off the week on a high note, with the shares adding more than 3% to close at $11.55. In fact, the stock finished atop both its 10-day and 20-day moving averages for the first time since April 2, when HMA touched a six-year high of $13.63. Nevertheless, some options traders are gambling on limited upside for the security in the short term, as evidenced by yesterday's affinity for short calls.

By the time the dust settled, Health Management Associates saw more than 5,500 calls cross the tape -- almost 10 times the norm. For comparison, fewer than 300 puts were exchanged. Digging deeper, nearly all of the action transpired at the November 13 call, which saw a block of 5,182 contracts change hands at the bid price of $0.80 each, suggesting they were sold. Plus, all of the volume translated into new open interest overnight, confirming our theory of fresh initiations.

By selling the calls to open, the traders have one of two motives: to profit from limited upside over the next several months, or to "cover" a long stock position. In the case of the former, the sellers want HMA to remain south of $13 through November options expiration. In this best-case scenario, the calls will remain out of the money, and the sellers can retain the entire premium received at initiation.

In the case of the latter, the Health Management shareholders expect a bout of intermediate-term stagnation, and want to supplement income in the meantime. However, should HMA climb atop the $13 level within the calls' lifetime, the contracts will move into the money, and the covered-call writers could have to part with their stake, missing out on additional upside.

Whatever the motive, this is a relatively risky play, especially with earnings on the horizon. Specifically, the company is slated to unveil its first-quarter earnings after the closing bell on Thursday, May 2. A stronger-than-anticipated report could send the stock higher. However, it's worth noting that HMA has fallen short of per-share profit estimates in three of the past four quarters, and the firm recently warned that first-quarter figures could once again fall short of consensus estimates.

As alluded to earlier, Health Management Associates finished solidly higher yesterday, thanks to buzz about potentially better-than-expected inpatient hospital payment rates from the government this upcoming fiscal year. The final ruling on Uncle Sam's proposal is expected Aug. 1 -- also a potential catalyst into the black for HMA.